Educational Articles

Stock Screen: Highest Yielding Small-Cap Stocks - December 14, 2012

Kevin Downing
| December 14, 2012

A number of investors are always looking for angles, tricks, or tips that will provide an edge. One such historical anomaly is stocks of smaller companies, have, over periods of time, provided higher returns than their larger-cap counterparts. Of course, this added return comes at the price of additional volatility, but for aggressive investors, a little more risk for more reward isn’t a major concern.

Conservative investors, however, would likely take umbrage at such an idea. For these individuals, the added risk simply isn’t worth the potential for higher returns. Even so, there are many ways to slice and dice a category of stocks. For example, one could simply limit his or her universe to small caps with low Beta coefficients (a measure of volatility to a broader market index). Although this alone would limit the investment options to stocks that are statistically less volatile than a broad index, it says nothing about the actual companies under consideration.

To get a better grasp of a small company while still leaving plenty of room for variety, dividend yield is another good addition to the screening process. Dividends can’t be faked or taken back, so they are often viewed as providing insight into a company’s finances and management. Although nothing is universal, searching for small company stocks with low Betas and relatively high dividends should create a good starting point for conservative investors desiring some small cap exposure.

We created such a screen using Value Line’s proprietary online system only to find that including Beta only shortened the list by a few names, suggesting that it didn’t add as much value as we had anticipated. As such, we altered the screen and simply looked for stocks with market caps between $100 million and $1 billion, and dividend yields above 3%. Consequently, the list was a little longer, but it was more varied, allowing for the question, “Is an 8% dividend yield actually worth the risk of a stock that is slightly more volatile than the market?”

Subscribers can replicate this screen using Value Line’s online stock screener, with or without the addition of Beta. Our non-Beta version of this screen turned up high dividend yielding small caps like offering a collection of risk/reward combinations, as well as solid investment prospects and varying dividend yields. For this screen we have chosen to highlight Einstein Noah Restaurant Group (BAGL).

Einstein Noah Restaurant Group

Einstein Noah is the biggest owner/operator, franchisor, and licensor of bagel specialty restaurants in the United States, with more than 797 locations in 39 states and the District of Columbia as of October 6, 2012. It operates under the Einstein Bros., Noah’s New York Bagels, and Manhattan Bagel brands. Roughly 90% of total sales are derived from company-owned stores, while over 60% are generated during breakfast hours. Coffee and specialty beverages comprise roughly 10% of the top line while catering sales make up 8%. Marketing expense has historically been around 3% of sales.

Einstein’s third quarter results were mixed. Company-owned restaurant sales grew 3.4%, excluding the planned closure of five food commissary facilities done to help streamline the supply chain and lower costs. If the closings are factored in, revenues rose 1.9%. This tactic appears to have had its desired effect, as the cost savings helped EBITDA grow 13.6%. A 4.1% increase in the average transaction amount stemmed from a favorable product mix shift, higher pricing, specialty beverage sales, and a 19.4% rise in catering sales. Still, this was almost fully offset by a 3.9% fall in traffic, as same-store sales only advanced 20 basis points year over year.

Management appears focused on getting more heads through the door. First, a new loyalty program is being tested to better understand customers and their buying habits. The company is also trying to appeal to the cost conscious via a new value menu that’s being rolled out in a matter of weeks. This strategy has proven quite successful for other quick service restaurants, chief among them McDonald's (MCD – Free McDonald's Stock Report). Emphasis on hot beverages is also expected to increase visit frequency, and BAGL aspires to grow this side of the business from the current 10% of revenues to 15%. For the health conscious, its Smart Choices menu has 14 items priced below $5 with 350 calories or less. Most importantly, the company is trying to improve its lunch and dinner traffic —which has been the primary problem— through special offers after 3:00 PM as well as extended store hours. This strategy is being tested at two stores and traffic has improved.

The potential for “off premise” sales growth looks appealing. In addition to a longstanding relationship with Costco Wholesale (COST), which sells some high-volume varieties of Einstein bagels, the company is in the midst of rolling out its lineup of Thintastic bagels into Wal-Mart Supercenters (WMT – Free Wal-Mart Stock Report). The world’s largest retailer’s economies of scale ought to drive long-term growth for Einstein.

Elsewhere, new types of data collection enabled by a refresh of its payment terminal infrastructure should help with marketing strategies, as well as more efficient pricing and in-store inventory management. Also, the company has secured price protection for around 33% of the wheat it plans on using in 2013, and 96% of its coffee. While wheat inflation is expected to be 5.5%, coffee costs should come down 22%. An estimated 2%-3% increase in total raw materials cost should be offset by efficiency initiatives.

Management remains focused on store openings and is on pace to launch 66 to 72 units in 2012. It already has 120 franchise commitments in place for 2013 and beyond, which gives us confidence in future footprint expansion opportunities.

On December 6, 2012, Einstein's Board of Directors announced that it completed a review of strategic alternatives. The result was a recapitalization of the company that increased its term loan A from $75 million to $100 million and the revolving credit facility from $50 million to $75 million. The money will be used to fund a one-time special dividend of $4.00 per share, the ongoing quarterly dividend of $0.125 (currently yielding 3.17%), working capital, capital expenditures, and other general corporate purposes. The total cash outlay for the one-time special dividend will be approximately $68 million. It is payable on December 27, 2012 to shareholders of record at the close of business on December 17, 2012, and will have an ex-dividend date of December 28, 2012. This is in addition to the regular quarterly dividend of $0.125 per share (currently yielding 3.17%). We think this provides evidence that the company has the best interests of its shareholders in mind.

Overall, we think these shares offer a good way to gain exposure to the quick service restaurant industry.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.